Banks May Lose the Protection of the “Too Big To Fail” Shield


Banks are going to have to stand on their own two feet. Recently, the Federal Reserve Board proposed a new rule that applies to domestic and foreign banks operating in the U.S., considered by the Board as globally systemically important banks (GSIBs) and to the U.S. operations of foreign GSIBs – translation – the big banking guns, the household names.

These institutions would be required to meet a new long-term debt requirement and a new "total loss-absorbing capacity," or TLAC, requirement. The requirements will bolster financial stability by improving the ability of banks covered by the rule to withstand financial stress and failure. Essentially the good news here is that the pressure is being taken off the government and taxpayers if they get in trouble. The phrase "too big to fail" isn’t going to cut it any more.

According to a statement from the Fed, to reduce the systemic impact of the failure of a GSIB, an orderly resolution process should allow a GSIB to fail, and its investors to suffer losses, while the critical operations of the firm continue to function. Requiring GSIBs to hold sufficient amounts of long-term debt, which can be converted to equity during resolution, would facilitate this by providing a source of private capital to support the firms’ critical operations during resolution.

"The long-term debt requirement we are proposing today, combined with our other work to improve the resolvability of systemic banking firms, would substantially reduce the risk to taxpayers and the threat to financial stability stemming from the failure of these firms," Chair Janet Yellen said in a prepared statement at the time of the announcement. "This is an important step toward ending the market perception that any banking firm is ‘too big to fail’."

According to published reports, six of eight big banks (Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street and Wells Fargo), would need to raise an additional $120 billion to meet the requirements.

According to published reports, six of eight big banks would need to raise an additional $120 billion to meet the requirements.

Dr. Oonagh McDonald, an international financial regulatory expert and author of the forthcoming book, Lehman Brothers: A Crisis of Value, sheds light on how the proposed regulations could change things.

"The banks will have to issue $120 billion in new long-term debt by January 1, 2022. Because the banks have to get at least some of the funding through long-term debt, rather than short-term debt, they will have to put up with whatever investors charge the banks to borrow, but because they are so large, it may not push up costs too much," says McDonald.

Ironically, she says, Standard & Poor’s response was that they would cut the ratings of the banks concerned because the government is less likely to bail them out in a future crisis. "They’re on credit watch negative – a 50% chance that their ratings would be cut in the next three months, that could make the cost of issuing debt more expensive."

Two of the banks concerned are so large partly because of their purchases during the crisis or in the run-up to it. "Bank of America saved Merrill Lynch from collapse during the fateful weekend when Lehman Brothers collapsed with the then-government’s knowledge," says McDonald.

JPMorgan Chase bought Bear Stearns at the government’s behest and with government support in March of 2008. "Still, all this rests on the wrong diagnosis," says McDonald.

"Government housing policy led to the financial crisis – the extent of subprime mortgages in June 2008 – over 50% of all mortgages at the time, led to many bank failures. The crisis wasn’t due to ‘casino’ banking, but to the familiar government-sponsored bad lending," says McDonald.

She explains that it wasn’t that banks were too big to fail, but that banks’ assets were concentrated in subprime mortgages and mortgage-backed securities and other derivatives.

McDonald contends that Lehman Brothers, one of the largest banks of the world, did not lead to the failure of any other bank. "Interconnectedness was not the problem. That was the sudden realization that no one knew the value of anyone else’s assets – a destruction of trust, together with the realization that the government was not going to bail out any large bank. All of Dodd-Frank and the designation of all banks and bank holding companies with more than $50 billion in assets as a systemically important institution, is based on that interpretation, but it is the wrong basis."

Previous Comments
  |     |   Comment #1
it was packaging subprime mortgages as good debt which is what the banks did.  it was fraud.  they are trying to blame the government for them playing with junk mortgages.  what a load of crap.  the government shouldn't back these mortgages then see how those same banks whine
  |     |   Comment #2
90 day commercial paper that was not rolled-over was a big that may be a thing of the past and banks will only be looking for "good" deposits in the future or their reserves go up!!!!
  |     |   Comment #3
Break the big banks up to create greater competitiveness, legislate there will be NO taxpayer bailouts under any conditions and stop backing mortgages, student loans and every other financial transaction entered into by individuals for personal benefit. Those of us that repaid each and every debt during our lifetime have had enough.
Kenneth Metviner
  |     |   Comment #4
Whom are we trying to protect, the depositors or the employees/suppliers/local communities? Depositors have the FDIC.  The fact that the FDIC did not have enough reserves in 2008 was at least partly due to their non-collection of premiums as mandated by the government.  Government, again, was the culprit.  The employees et al deserve at least some consideration, and that is at least part of the reason for TARP, etc. None of what is being proposed helps in any way except to maske the politicians think they are doing something.
  |     |   Comment #5
Whatever we do, please don't socialize the banks with greater govt control. As long as the banks don't have to compete and they are saddled with higher costs due to regulation-compliance issues, there will be little incentive for them to raise rates. Hopefully, with the greater capital requirements imposed on them, they will voluntarily spin off large divisions and regional branches so some of these mega banks will become a more manageable size, fostering more competition within the industry.
  |     |   Comment #6
Five banks control nearly 50% of assets. We are all insane to believe this is wise or healthy for the economy. They, however, control the political landscape and, therefore, can enslave each and every depositor through fees, low rates and poor service. Pretty soon we'll just refer to it as THEBANK, because there will be only one. 
  |     |   Comment #7
The banks, and their executives, have the most risk but they haven't figured that out since the Bank Panic of 1907 which triggered the Fed Res Act.  Unfortunately it will take another Great R or D
  |     |   Comment #8
This must be a very serious issue since it was one of the questions asked of the candidates on the recent Republican Debate.  However, no candidate mentioned anything about the customers being FDIC insured if a bank failed.  Do they know something we don't know??  Are there any banks today which are not FDIC insured and if so, does anyone know who they are?  Thanks!
  |     |   Comment #9
This is just a guess, but maybe what they failed to clarify in their question:

If a megabank failed, and there was not enough funds in the FDIC to cover the insured depositors, would you let the bank fail anyway and also not bail out the amount the bank owed to the insured depositors?
  |     |   Comment #10
Banks are not what people think they are. They have insured depositors but they also engage in very risky "investments" that are the source of all their troubles. Money today is nothing more than digital signals moving around computer networks, often at great peril when leveraged 100-1. The question posed to the candidates was poorly worded. FDIC insures deposits, not the immoral gambling undertaken by "bankers". The immoral gambling is insured by YOU, the taxpayer. ****, we are a bunch of chumps.  
  |     |   Comment #11
You/us better hope they are all insured! 
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